Succession plans are essential for small businesses - East Valley Tribune: Business

Succession plans are essential for small businesses

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Posted: Tuesday, May 31, 2011 5:00 pm

Many small-business owners are so busy running their businesses that they don't take time to consider who would take over if they became disabled or died.

"It's the goose and golden egg syndrome," said Mark Luttner, managing partner of Iron Bridge Financial in Pittsburgh. "The business owner is the goose, and all too often we insure the egg.

"The buildings, equipment and hard assets are insured and protected," he said. "But the owner is driving everything like morale and day-to-day operation. If something happens to the owner, everything is at risk."

For business owners who envision their companies as an ongoing enterprise after they are gone, a succession plan cannot be postponed.

It's estimated that more than half of all public and private companies have not named a successor.

Raymond Vargo, director of the University of Pittsburgh's Small Business Development Center, said many proprietors "know having a succession plan is a good idea. They just don't have time to get around to it while putting out day-to-day fires. When we work with companies, we identify this as an issue and recommend they dedicate the necessary time to create one."

Luttner is familiar with a family that once owned a thriving manufacturing firm in Eighty Four, Pa. It was shut down when the owner died without a succession plan, leaving his surviving family members with no income stream and workers with no jobs.

The owner, who was in his 60s, had recently remarried, and his stock passed to his young wife. The owner had signed personally for his lines of credit. When he died, creditors called most lines of credit and accounts payable. Without operating capital and the ability to buy materials on credit, doing business became difficult. The widow liquidated the equipment and inventory, and sold the real estate.

Several employees, including one of the owner's sons, showed up for work one day only to discover they were suddenly unemployed.

"All of this could have been prevented had there been a couple of things in place," Luttner said. "The owner should have had a will or a buy/sell agreement so that the stock would have been transferred to the son.

"There should have been a life insurance policy in place insuring the dad, that would have given the son the capital he needed to purchase the stock from his stepmom at fair value and provide additional operating capital."

Picking a successor is no easy task, said Fred Rock, managing director at Focus Investment Banking LLC, a national firm with a Pittsburgh office. It advises clients on buying and selling businesses.

He said business owners must determine if the company would be better off in a relative's hands or a key, unrelated employee.

"Most parents don't take an honest look at their child. The child runs the business into the ground, and there is no income from the business. We see that happen a lot.

"Another option is to sell the business to a key employee. ... They could buy the business out of its profits over three or four years and it could be a win-win. But sometimes good employees are not good owners."

Rock said selling a business to employees who do not have the capital to purchase it could be risky. The employees may be good at following, but not developing, a plan.

If an employee purchases the business from the owner over a period of time and ruins the business, the owner and his family could be left with nothing.

"The decision you must make is one that is ultimately best for the business," Rock said. "That could mean choosing one sibling over another to run the business or choosing an employee.

"But in either case, you have got to be careful to evaluate whether they have the skill sets to continue to operate the business successfully."

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